What is interest? Types and Methods of Interest Calculation
Interest is the amount paid by the person receiving the money to the person giving the money in addition to the money given as a loan to another person to be returned at maturity. Another explanation is as follows, interest is the rent of money. The share of profit on the given money is called interest.
What is interest?
Interest is one of the most common concepts in financial transactions, and in a loan transaction, it is the amount added to the debt upon repayment of the debt of the debtor. It is usually expressed as a percentage and means that the debt has increased by a certain percentage over time.
In other words, interest is the additional cost of the amount of money lent by the creditor to the debtor during a loan transaction, which increases over a period of time. This cost is the amount of interest that the borrower must pay when repaying his debt. The interest rate is determined by the lender and borrower and is calculated based on the amount of money borrowed over a period of time. The interest is usually expressed on an annual basis, but can also be calculated on a monthly, weekly or daily basis.
Interest can be applied to various types of debt, such as credit card debt, personal loans, home loans, and business loans. Interest can also be paid on an investment vehicle such as a savings account or a bond. Interest is important to both the lender and the borrower. While interest allows the lender to make a profit on his investment, the borrower repays his debt by paying interest. Interest can also affect economic growth by affecting the supply and demand of money in an economy.
What are the types of interest?
There are, of course, different kinds of interests. One of the most curious topics of people lately is what kind of interests there are. Here is information about the types of interest;
1. Loan Interest
The state does not intervene on this type of interest set by the banks.
2. Deposit Interest
Another name given by the banks is market rate, and the deposit rate is not hindered in any way by the government.
3. Bond Rates and Bills
The state does both. Government bonds are valid for more than 1 year. Treasury bills have maturities of less than 1 year. Companies generally don’t use them, they issue most of the stock.
4. Rediscount interest
This rate, which is also one of the monetary policy instruments, is the rate applied to commercial paper issued by the banks to enable the Central Bank to meet the temporary liquidity needs of the banking sector. The Central Bank can also provide advances on these securities.
5. Repo / Reverse repo
Sell with the promise of repurchase. The Central Bank sells securities and takes money from the market by conducting reverse repos when it believes there is excess liquidity in the market. As an instrument of monetary policy, the Central Bank uses bonds to conduct monetary policy because it is determined by the government. The type of interest that the Central Bank will pay back on lending is repo and reverse repo. The Central Bank determines the amount of money that is released by playing with the short-term interest rate.
The Central Bank indirectly determines the interest rates in the market with the interest rates in its hands. At the same time, this shows that he could not intervene in the market and that the monetary policy tool he implemented did not produce the desired result and did not apply this tool properly. Lowering interest rates increases the amount of money released into the market, and because interest rates are low, the increased amount of liquidity is used by consumers. This meant an increase in production, consumption and national income and was called the Transfer Mechanism.
6. Net Interest / Gross Interest
Gross interest, called net interest, is the interest rate mutually agreed upon by both parties. The rates found by adding or subtracting the costs incurred for both the debtor and the creditor are called net interest or gross interest.
Interest Calculation Methods
Interest calculation plays a very important role in financial transactions between lender and borrower. Different calculation methods are used for interest rates, credit card interest, home loans, personal loans and other types of debt. Therefore, knowing the correct interest calculation methods is essential for financial planning and budgeting.
Simple interest calculation method
The simple interest calculation method calculates the amount of interest that the borrower must pay over a period of time at the interest rate set by the lender. This method is the most basic method of calculating interest on debt and is often used for short-term debt.
The following formula can be used to calculate simple interest:
Simple interest = debt x interest rate x duration
For example, if 1,000 TL is borrowed and borrowed for 1 year at a simple interest rate of 5%, the interest amount to be calculated is as follows:
1,000 TL x 5% x 1 = 50 TL
Compound interest calculation method
Compound interest calculation method is a method in which the interest on the debt is calculated together with the interest paid in previous periods. This method is used for long-term debt on debt and is used when the interest rate on the debt can change frequently.
The following formula can be used to calculate compound interest:
Compound interest = debt x (1 + interest rate / number of periods)^(number of periods x duration) – debt
For example, when 1,000 TL is borrowed and borrowed for 1 year at a compound interest rate of 5%, the interest amount to be calculated is as follows:
Compound interest = 1,000 TL x (1 + 0.05 / 1)^(1 x 1) – 1,000 TL = 50.63 TL
Interest and credit relationship
Interest and credit are closely linked in the financial world. While interest rates determine the cost of borrowing, they are also a determining factor in loan demand. Therefore, understanding how interest rates affect loan applications is an important factor to consider before taking out a loan.
How interest rates affect interest rates on loans?
Interest rates directly affect lenders’ responses to loan applications. In general, low interest rates increase the demand for loans and more people try to get loans, while high interest rates cause the demand for loans to decrease.
The interest on the loan is calculated according to the interest rate determined during the loan application. Interest rates are based on many factors that lenders determine, for example, they vary with the borrower’s credit history, income level and loan type.
For example, a borrower with a good credit history may be able to get a loan at low interest rates, while a borrower with a weak credit history may need to take out a loan at high interest rates. In addition, the interest rates may differ depending on the type of loan. For example, home loan interest rates are generally low, while credit card interest rates can be higher.
The role of interest rates in loan applications
Interest rates are an important factor when applying for loans. When applying for a loan, the borrower must consider how the interest rates on the loan will affect their budget and payment schedules. Also, interest rates affect the total repayment amount required to repay the loan.
It is important that the borrower has accurate information about interest rates when applying for a loan. That is why it is important to compare the interest rates and terms of different lenders to find the most suitable loan option.
How is the interest determined?
The interest rates are based on many factors determined by the lender. These factors may include market conditions, economic indicators, the type of loan, the borrower’s credit history, income level, and the loan amount.
How to avoid loans with high interest rates?
To avoid loans with high interest rates, it is important to do careful research before borrowing and compare the interest rates and terms of different lenders. Also, a good credit history is key to low interest rates. Borrowers can positively impact their credit scores and credit history by sticking to their loan repayment schedules.
How long will the interest payments continue?
Interest payments can vary depending on the type of loan and the payment schedule set by the lender. For some loans, interest payments continue throughout the loan amortization period, while for some loans, principal loan payments begin after interest payments are made for the first few months.
Are low interest loans beneficial?
A: In general, loans with lower interest rates are more beneficial because borrowers pay less interest and have a lower total repayment amount. However, depending on interest rates, it may be more difficult to have low interest rates on some loans.